Terry Connelly is dean of the Ageno School of Business at Golden Gate University and is frequently quoted on business, financial, and economic issues by Bay Area local, as well as national, news media.
The Paulson Plan to provide relief for homeowners with subprime mortgages due to reset in early 08 has been attacked as a both a dangerous “moral hazard” and “too little, too late” — quite logically, it can’t be both! If it’s minor, it’s not hazardous, and if it’s really a bailout of immoral proportions, well then it’s not “too little”.
The reality is more related to the legal constraints under which the Treasury Secretary was operating than anything else. Indeed, the very narrow category of homeowners who are eligible for the relief fits neatly into the standard clauses in the securitization documents allowing mortgage eervices to vary repayment and reset arrangements only when, in summary, the outcome of such changes would be most likely to be better for the holders of the obligations than sticking with the original terms (ie, and let foreclosure happen and take chances with the resale market).
This contractual test would appear likely to be met in the case of borrowers with substandard credit scores and whose mortages are 97% or more of the value of the home at current market; these borrowers — the prescribed beneficiaries of the Paul Plan — virtually define a category most likely to default into foreclosure. The Paulson Plan, accordingly, hardly can be said to do violence to the ‘sanctity of contract’ since it basically tracks the circumstances where contracts, on-a-case by case basis, actually provide for the type of relief proposed. All Paulson has done is wrap it all up in what the Administration is surely loath to call a “class action”.
The problem for the market and the economy (not to mention the homeowoners) is that this same category of borrowers has little to gain from signing up for the extension of even their existing ‘teaser’ rate mortgages — which were improvident in the first place — especially against a backdrop of home values that have fallen to such a shallow margin over the amount of the mortgage. Financially, they could well be better off dropping drop off the keys and renting!
In the end, this Plan is no panacea for the next round of resets due by the Spring, and not surprisingly the equity and debt markets are beginning to more seriously consider the real prospect of a recession in the next year. Will the Fed be as disappointing as the Treasury?
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